Balancing act for ARCs when using resolution tools

Under the framework of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI), an asset reconstruction company (ARC) has wide powers to revive a company facing financial difficulties. It can use securitisation, reconstruction and recovery for quick resolution of distressed debt. As an alternative, the Insolvency and Bankruptcy Code, 2016 (IBC), allows ARCs with access to a formal resolution process, which has the advantage of the borrower emerging debt-free with a clean slate.

However, companies in India usually have a large and varied debt portfolio as there are conditions on the end-use of loans, especially when banks/FPIs are lenders. Additionally, not all lenders are eligible to assign their loans to an ARC. This varied debt-holding pattern of an Indian company in financial difficulty, coupled with the regulatory restriction on what an ARC can purchase poses a practical problem. An ARC intending to acquire the debt of an Indian borrower therefore needs to consider the objective of acquisition as well as post-acquisition steps. This entails evaluating whether resolution or recovery is the best option in dealing with the acquired debt.

In India, the position of the ARC in the debt portfolio becomes an important factor in determining whether restructuring is viable. This is primarily because cramdown is not a recognised principle in India for ARC-led resolutions. Minority or holdout creditors continue to have a say through the IBC framework. Recent incidents both within and outside IBC resolutions have shown that despite much money, time and effort being spent by an ARC on restructuring the debt, it is not certain that such restructuring efforts will succeed. This is especially so if a minority or an operational creditor can push the company into IBC resolution or continue to thwart the ARC’s restructuring efforts.

Practical concerns are illustrated by the recent National Company Law Tribunal (NCLT) case of Bank of Baroda v Arch Pharmalabs Limited. The ARC, JM Financial (JMF), found its rights compromised as Bank of Baroda, as a minority debt holder, applied for the initiation of a corporate insolvency resolution process under the IBC. The NCLT admitted the application, even though most of the debt was held by JMF and greatly exceeded that held by the bank. JMF did not want Arch Pharmalabs to go through an IBC resolution. The NCLT decided that although JMF held 90% of the debt, it could not be allowed to override the interests of the other creditors. While the case cannot be faulted on legal principles, it contains a valuable lesson for any ARC considering restructuring the debt of a borrower that has other creditors who may not favour such a plan.

When an ARC acquires the debt or is willing to grant further financial assistance, it is not thinking of an IBC resolution. In such a case, obstruction by a minority lender or operational creditor, especially when they are trying to use the IBC as a recovery tool, can pose significant challenges for an ARC. This poses the question of what an ARC should then consider while restructuring an asset. Clearly, holding a majority of the debt portfolio or being the sole or majority secured creditor is not sufficient. An option is ensuring the minority financial creditors sell their exposure to the ARC, making the ARC the sole financial creditor. Alternatively, the minority creditors may agree with the ARC to renegotiate the restructuring terms by letting the ARC lead the efforts under the available SARFAESI statutory framework. Because the IBC resolution remains a fallback, collaboration between lenders is essential if restructuring for ARCs is to be meaningful. For a restructuring under the SARFAESI to be effective, the ARC must therefore evaluate the rights of the other creditors, too.

Where loans are sold on a standalone basis by a financial creditor, including those following the open-bidding Swiss Challenge method, the theory that an ARC co-ordinates with all the lenders is difficult to put into practice. Another consideration is the role of National Asset Reconstruction Company Limited, where the intention is to resolve an asset outside the IBC process.

While resolution outside the formal IBC framework needs to be robust for any economy to grow and survive through entrepreneurship, the issues facing specialised statutory vehicles such as ARCs needs specific attention and intervention not only by the regulators but also by the government.

Veena Sivaramakrishnan is a partner and Sumant Prashant is a counsel at Shardul Amarchand Mangaldas & Co.